Air

Carrier
Industry
Analysis
Strategic Management 471W
Corinne Conto, Brennan Miller, and Hannah Neckers

Penn State
Erie

Table of Contents
Overview..........................................................................................................................................2
Industry Definition...........................................................................................................................3
PEST Analysis.................................................................................................................................5
Porters Five Forces.......................................................................................................................11
Barriers to Entry.........................................................................................................................11
Supplier, Substitute, Rival, and Buyer Powers..........................................................................15
Competitive Advantage/Performance............................................................................................22
Analysis of Key Firms...................................................................................................................24
Alaska Airlines...........................................................................................................................24
American Airlines......................................................................................................................26
Delta Air Lines...........................................................................................................................27
Jet Blue.......................................................................................................................................29
Southwest Air.............................................................................................................................32
Air Carrier Industry Evolution.......................................................................................................34
Entrance of Imitators/Re-organization of Incumbents...............................................................34
Maturing of the Leading Firms..................................................................................................34
Mistakes by Incumbents.............................................................................................................35
Threats to Core Activities (PEST).............................................................................................35
Threats to Core Assets................................................................................................................36
Conclusion.................................................................................................................................37
Recommendation...........................................................................................................................38
Appendix........................................................................................................................................40
Figure 1......................................................................................................................................40
Works Cited...................................................................................................................................41

Overview
The basis of this report is to define the domestic airline industry and then analyze this industry in
regard to a set of specific criteria provided for the analysis. The first task that this analysis covers
is defining the industry. After the airline industry is outlined, a more indepth look will be taken
in order to determine how the industry functions. A PEST analysis will be used to evaluate the
airline industry in terms of its political, economic, and technological environment. The
information gathered in the PEST analysis will then be used to examine the first of Porters Five
Forces: barriers to entry. This section will include an outline of the issues that potential new
entrants to the market would face, in addition to how these barriers help or hinder the firms
currently in the market. The next segment that will be explored is the remaining four of Porters
Five Forces. These forces will include supplier, buyer, rivalry, and substitute power. This
segment determines how the power to control profits within the industry is distributed, in
addition to which forces hold the most power. Next, a performance analysis of the airlines within
the industry will be conducted by evaluating the financials over the period of 2009-2013. This
analysis will be used to determine which firms consistently operate above the industry average.
Following the performance analysis, firms will be examined individually to determine what
resources offer or prevent a competitive advantage. Finally, using all of the information gathered,
a prediction will be made about the evolution of the airline industry in the years to follow, in
addition to recommendations for future investors.

Industry Definition
An industry is a set of firms that solves the same economic problem in the same way (Warner,
2010). When defining the airline industry there are certain aspects that must be determined. The
four key issues that must be defined in regards to the industry are who are the customers, what
are the problems in the industry, how these problems are solved, and a list of firms that meet
these requirements.
First, in order to define an industry, there must be a group of customers searching for a solution
to a common economic problem (Warner, 2010). The consumers in the airline industry range
from business men and women to those flying for leisure. Generally speaking, customers are
looking to transport goods or people in a time-efficient manner. Some key customer needs
include: a strict and timely schedule, reliable service, accessibility to scheduling flights, safety,
customer service, competitive pricing, a variety of destinations, and so forth.
People need to be able to transport themselves in a safe and efficient manner. The airline industry
has the necessary capabilities to solve this problem. These needs are met by having scheduled
flights that can transport passengers to predetermined locations. Airlines are able to offer a
quicker way to travel compared to other forms of transportation. They also provide safe flights
for passengers through their security measures. Lastly, airlines are extremely accessible within
the United States making them a viable means of transportation.
The airline industry can be defined as scheduled passenger air transportation over consistent
routes (Brennan 2013). There are many important pieces of information to consider about this
description of the airline industry. The first section of importance is air transportation, which
means that transportation must be provided by an aircraft. The next piece to consider in the
explanation is scheduled transportation. The word scheduled is especially important because it
means that flights are predetermined and cannot happen at random. Due to the complex nature of
setting up a flight, one cannot be added at random because it could adversely affect the system.
The last part to consider is passenger transportation. Acknowledging that fact that there are
specific airline companies that are dedicated to passenger transportation, the industry can be
separated by what an aircraft is carrying.
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Each firm within the U.S. air carrier industry competes by achieving some form of competitive
advantage, while still meeting consumer needs and solving consumer problems. Frequent flyer
programs, availability of various destinations, frequency of flights, friendliness of staff, and
overall experience all play a role in which airline a customer may choose.
The airline market in America appears to be highly concentrated. According to CNN (2013),
several airlines have experienced periods of bankruptcy, causing a need for mergers in order to
remain in the market. Within the last twelve years, ten major airlines have been condensed into
four larger carriers: American Airlines, Southwest, Delta, and United (Yellin, 2013). These four
mega-carriers are composed of:
1.) TWA, American Airlines, U.S. Airways, and America West
2.) Southwest Airlines, Valujet, and Air Tran
3.) Northwest Airlines, Delta Airlines, and Western Airlines
4.) Continental Airlines and United Airlines
The market share is among the largest firms is as follows: American controls 21.2%, Southwest
15.7%, Delta 16.3%, and United 15.6% (RITA, 2014). Another key player that should be
included is JetBlue, controlling approximately 5% market share.

PEST Analysis
A PEST analysis is a comprehensive look at an industry in terms of the political, economic,
social, and technological environments. For this analysis, the social environment will be emitted
from the analysis but the other factors will be looked at in detail. Within each environment, there
are certain factors that could have a serious impact on the airline industry.
The first environment that will be looked at is the political environment of the airline industry,
which can be analyzed by defining important issues within the industry. After considering all the
political issues encountered in the airline industry, the most significant issues lie within
governmental regulations.
The Airline Deregulation Act of 1978 removed governmental control and restrictions on airlines
concerning their prices, routes, and market entry. However, starting in 2009, the Department of
Transportation established the Enhancing Airline Passenger Protections as a way to increase
protection for consumers and to increase their rights. There have since been three revisions to
this mandate (Tang 2013). Many view these new rules as the government trying to re-regulate the
industry. While the DOT had good intentions, these new requirements can have serious
ramifications for the airline industry.
According to Rachel Tang, an analyst in the transportation industry, the overall implication of the
new rules is that they will take millions of dollars to implement (Tang 2013). It is predicted that,
since 2009, regulations to the airline industry will raise the cost more than $1.7 billion dollars
annually over the next 10 years (Jenkins 2011). This will most likely translate to higher costs for
passengers, as the airlines will increase ticket cost in order to help cover their added expenses
based on these regulations. This could be especially serious in the areas of leisure and holiday
travel as consumers in this segment have higher price sensitivity than those in the business travel
segment. Overall, consumers do not react well to price increases and their reaction could have a
negative impact on the industry in terms of profit if they find other means of transportation.
Two noteworthy rules from the Enhancing Airline Passenger Protections that could have a
significant impact on the airline industry and its consumers are the tarmac delay rule and a new
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advertising policy. These rules were meant to benefit consumers; however, they are causing
financial ramifications within the industry. Consequently, airlines, as well as consumers, will be
financially affected.
The tarmac delay rule was implemented to avoid long delays on the tarmac and to make sure
passengers are adequately cared for if a delay does occur. The rule imposes a considerable fine
on an airline if it has a plane on the tarmac for more than three hours (Tang 2013). While this
rule appears to have been successful because flight delays have decreased, it has actually created
another problem. To avoid fines for delays, airlines have started cancelling flights instead.
According to a report paid for by The American Aviation Institute, cancellations are now 24%
more likely under this new rule (Jenkins 2011). This only compounds the problem of keeping
flight schedules on track. Canceled flights displace passengers which can disrupt the flow of
travel because airlines then have to deal with extra customers. The report from the American
Aviation Institute estimates that the total cost of cancellations from 2011-2020 will be
$2,223,188,994. This indicates that approximately 150,000 flights will be cancelled, costing
airlines nearly $15,000 per year (Jenkins 2011).
The second new regulation that the government has instituted is a new advertising policy that
requires airlines to include taxes and additional fees in their advertised prices. This new policy
will created another financial burden on the industry as the estimated total cost of abiding by the
new advertising policy will be $166,911,500 for 2011-2020. These costs will be incurred as
result of the changes that will need to be made to the airlines websites and advertising
campaigns (Jenkins 2011). Before this policy, airlines did not have to include taxes and fees in
the advertised price of a ticket, as long as the information was found somewhere in the
advertisement. This change makes ticket prices appear much higher, which is disconcerting to
consumers. Airlines for America approximates that 20% of a tickets price can be attributed to
taxes and fees. This means that with a $300 ticket, $60 can be attributed to taxes and fees
(Jenkins 2011). This new advertising policy not only makes it appear that airlines are charging
more for their tickets, it also hides from consumers how much they are paying to the government
in taxes and fees. The policy will fix the problem of customers being upset when they discover
that the true ticket price is different from the advertised price, but the appearance of increased
prices could deter potential customers.
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Governmental regulations pose huge limitations on the airline industry. In particular, the
Enhancing Airline Passenger Protections threatens the industry. With a potential loss of profits
from people deciding not to fly due to higher prices and industry operating costs increasing, the
airline industry could face serious financial issues in the near future due to these new
governmental regulations.
The second environment that will be analyzed is the economic environment. The single largest
cost that airlines incur is the cost of oil, which is used for fuel to power the planes. Oil
expenditures account for nearly forty percent of an airlines cost, according to an article
published by Fox News (Seaney, 2014). A recent study explains that there is an eighty percent
correlation between fuel cost and revenue, which is a spike of almost twenty percent from a prior
study (Gara, 2013). This proves that as fuel prices rise, so do ticket prices. Furthermore, it shows
that ticket prices rise to a price greater than that required to cover the increased fuel cost. A
report further enhances the argument that oil prices do affect ticket prices. In this report, Doms
outlines how oil prices affect certain industries and he specifically talks about the airline
industry. He presents a graph that compares current oil prices to the airfare at a specific time
(Doms, 2011). The information offered in these articles and studies shows that airline ticket
prices are tied to oil prices, thus revealing an economic issue in the airline industry. Airlines
cannot pass the entire cost of rise in fuel prices on to the customers. This, in return, forces
carriers to lose profits, in order to maintain ticket sales. Based on these studies it can be reasoned
that oil prices have a great effect on the industry incumbents, as well as customers buying tickets.
Another key issue in the economic environment is how gross domestic product (GDP) relates to
frequency of air travel. According to a graph found in a U.S. air carrier industry case study, a
rough correlation can be seen between fluctuations in GDP and the percentage changes in air
traffic between the years 1997- 2010 (Warner, 2011). As GDP dropped, so did the amount of air
traffic that took place. Using the year 2004 as an example, as GDP increased, air traffic reached
its peak for the twelve year span. From this, it can be concluded that if national GDP continues to
raise in the future, so will the amount of air traffic. This, therefore, will lead to increasing
profitability for firms within the industry.

Upon examining the economic issues that have been outlined, it can be concluded that economic
issues do affect the airline industry. The correlation between oil prices and airfare must be
understood so that ticket prices can be adjusted in accordance with the rise and fall of oil prices.
In addition, a rise in gross domestic product indicates that there is more disposable income
available for consumers. Therefore, a rise and fall in national GDP plays a role in the frequency
of air travel being used as means of transportation.
The last of the environmental issues that will be covered in the PEST segment of this analysis is
the technological environment. There are two key technological issues that are prevalent within
the air carrier industry. First, the external issue of how advances with virtual meetings have
and will continue to impact airlines is an issue, followed by an internal topic dealing with air
traffic control and GPS navigation systems in planes.
The increased availability of technology and Internet bandwidth has completely transformed the
communication world as a whole. Up until 2009, communicating via videoconferencing was
unreliable. Bandwidth technology was not developed enough to handle a large corporations
network. Individuals would experience endless difficulties, such as delayed or frozen video,
audio and visual issues, and dropped calls. Face-to-face meetings were a necessity within the
business world, leading to a frequent need for travel. Now, teleconferences, handheld devices,
web-based meetings, and videoconferences have begun to eliminate the need for face-to-face
meetings, thus impacting the amount of travel taking place. For example, between 2008 and
2009, the company Cisco Systems decreased its annual travel budget from $750 million to $240
million (Boudreau, 2009). This was done through the implementation of conferencing
technology in place of airline tickets, hotel rooms, and other various travel costs accumulated
through an extensive workforce (Boudreau, 2009). Despite travel budgets decreasing, some of
these high-tech communication systems initially did not come with a low price tag. HP has
designed a system called Halo which ranged anywhere from $120,000 to $349,000. In
addition, the systems required a $9,900-$18,000 monthly service fee (Boudreau, 2009). As the
product has advanced and matured, systems have decreased in cost. For example, one new
system has recently been introduced by Google that carries a price tag of less than $1,000
dollars, which may make video conferencing a very viable option for companies as it achieves
greater market share (Thomson, 2014).
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The data above suggests that as technology continues to further develop, advance and decrease in
price, the airline industry will experience a decrease in business traveling. Businesses will be
trading their jet-lagged employees, high ticket and hotel prices, and opportunity costs of absent
workers for simpler methods, such as videoconferencing meetings that take place directly on the
office premises. While most companies have already implemented some type of web-based
meeting, there will be a wave of high-end video rooms being installed for managers and
executives who would normally travel to meet with each other (Ashkenas, 2010). More than
business people alone, these technological advancements have enhanced the everyday persons
ability to communicate with family and friends across the globe. Overall, this technology has
increased the human network, minimized the need for face-to-face interaction, and essentially
decreased the demand for airline companies flight services. This technology creates a
developing and ongoing threat to the carrier business.
The aircraft carrier industry is also being affected by internal technological issues dealing with
air traffic control. Currently, aircraft are guided by dated radar technology controlled by radio
beacons on the ground. This causes planes to fly in a zigzag pattern across the sky, insuring the
aircrafts remain within reach of a beacon at all times. Essentially, planes are wasting hundreds of
gallons of fuel because of this system. New GPS technology, entitled NextGen, has the
potential to save airlines at least 3.3 billion gallons of fuel a year, adding up to more than $10
billion annually by the year 2025 (Tarm, 2008).
NextGens technology involves a satellite-driven network, much like the GPS systems used in
cars and cellular devices. It has the potential to guide aircrafts in a straight-line pattern, providing
a GPS network for all air traffic across the country. In return, this will lower airliners greenhouse
gas emissions, decrease the risk of inflight collisions, improve efficiency of flight patterns, and
increase the number of possible landings and takeoffs at airports (Tarm, 2008). In theory, this
technology will revolutionize the industry, although an entirely new issue presents itself to the
Federal Aviation Administration: no one knows how soon NextGen will available for use. To
simply put it, NextGen has been funded billions of dollars for research and development, yet the
FAA keeps encountering issues, making it difficult to advance. Issues include: catering the
technology for each individual airport, finding funding and opportune times to implement
NextGen on aircrafts, and of course, a proper plan of execution for such a fast-paced industry
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(Lowy, 2013). The airline industry is continuously moving nonstop, every day. It is obvious that
finding an opportune time to make changes poses a threat. As fuel prices increase, Airliners
suffer, creating a need for increased fuel efficiency. Although NextGen could help solve this
issue, until the new GPS technology is fully developed and implemented, there will be a constant
struggle for airlines to remain financially stable and stay in business (Tarm, 2008).
Overall, as communication technology increases, the demand for business and leisure flights will
decrease. Second, from an internal viewpoint, the air carrier industry has potential to experience
increased efficiency through new GPS navigation systems. Until those systems are fully
developed, the industry may experience difficulty remaining profitable and staying in business,
due to high fuel prices and the inefficient, outdated technology currently in place.
Based on the research while performing the PEST analysis for the air carrier industry it can be
seen that there are multiple environmental issues within the industry. Therefore, it must be
understood how to handle these issues, even though many of their causes are outside of the
firms control. Firms must be learning how to mitigate effects and lessen the financial strain that
issues cause.

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Porters Five Forces

Michael E. Porter developed an analysis encompassing five forces that can affect an industry:
barriers to entry, supplier, substitute, rival and buyer powers.
Barriers to Entry
Barriers to entry within the airline industry can be classified as high, moderate, or low. Specific
barriers that can affect the airline industry are differentiation, switching costs, distribution
channels, retaliation by incumbents, learning curves, and government policy. These barriers all
impact the industry in distinct ways and have different levels of influence. These barriers will be
analyzed to determine what level of difficulty they impose on entering the airline industry.
The first area to be examined is differentiation, which is when customers are willing to pay more
because of brand loyalty. Loyalty is normally gained because customers are attracted to a
significant characteristic that is offered by a company. For differentiation to be relevant there
must be price levels, a choice of products, and significant product characteristics. Differentiation
exists if customers are willing to pay more for products due to loyalty.
Airlines distinguish themselves through the services they offer and the price of tickets. Some
additional differences can be the routes taken, time of flights, distance traveled, and classes of
tickets. Differences in services tend to categorize airlines into either being a network carrier or a
low cost carrier. Network carriers offer more amenities to attract customers, while low cost
carriers focus on offering the lowest ticket price. Due to the services network carriers offer, their
prices tend to be higher than low cost carriers ("U.S. low-cost airline," 2013). This shows that
there are price strata among the airlines, as well as a choice of products with certain
characteristics. Customers can choose an available airline to their destination, based on personal
preferences.
The above information indicates that a price levels exist within the airline industry. However, the
dynamics of the industry are changing due to customers becoming more price sensitive. As a
result of this, network carriers have had to lower their prices to compete with low cost carriers.

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These lower prices are forcing the network carriers to decrease the services they offer and
operate more like a low cost carrier. According to a report by the management consulting group
Oliver Wyman, low cost carrier unit revenue surpassed that of network carriers in 2013 ("U.S.
low-cost airline," 2013). This shows that customers are more concerned with the cost than they
are about the services that airlines offer. Therefore, differentiation is not a strong barrier to entry,
as loyalty to a specific firm only matters if ticket costs are comparable.
Switching costs are costs that are incurred when changing to a new product or service. Switching
costs involve sunk costs, which are investments that cannot be recovered. These parameters will
be the basis for analyzing differentiation and switching costs within the airline industry. For
switching costs to be pertinent there must be significant investments in a complementary good,
and in this instance a particular airline.
Airlines have tried to create switching cost is through frequent flier programs (FFPs). These
programs reward customers with either free flights or upgraded services after they have reached
a certain number of miles (Corridore, 2010). Airlines want customers to invest in these programs
so they are more likely to continue flying with them. However, customers do not actually lose an
investment if they fly with another airline. Customers simply do not earn miles for their FFP
through that airline. This indicates that there are no switching costs for customers within the
airline industry.
The third barrier to entry to be analyzed will be access to distribution channels. In order to enter
the industry, a firm must secure a channel through which to distribute its services. The main
channels through which distribution occurs is the use of airports (gate space) (Warner, 2010).
The next question is how to access this channel. This is where the largest problem lies: many
airports have contracts with existing airlines to provide them with a specific number of gate
spaces/flights per day. There are two main types of contracts that existing airlines have entered
into with airports, which include exclusive and preferential contracts. An exclusive contract with
an airport means the airline renting the gate space has sole rights to the gate, whether they have
flights or not. A preferential contract enables the air carrier to have the first rights to the gate if
needed; otherwise, the airport can rent it out to another airline (Lee, 2011). The contracts that are
entered into by existing airlines with airports make it very difficult for another airline to gain
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access to that airports gate space. For example, at all three New York City airports (Newark, La
Guardia, and JFK), there are slot limitations (Warner, 2011). This location would be a critical site
for entrants or incumbents to provide service to, seeing that all three locations are ranked in the
top 20 domestic airports in the country. This proves that such restrictions often limit and deter
entrants from entering the market. If the potential market entrant can in fact gain access to the
needed gate space, they will often have to pay a higher rate compared to established carriers, thus
reducing profitability (Lee, 2011).
Another barrier to entry to be analyzed is the threat of retaliation by incumbents. The threat of
retaliation exists anytime that a potential competitor looks to enter the market. However, there is
more threat of retaliation during specific instances such as when the growth of the market is
slow, or if those in the market can currently sustain demand (Warner, 2010). To better understand
the level of threat in the industry, the growth of the industry as a whole must be inspected. Data
provided by the Federal Aviation Administration (FAA) shows that the number of individuals
flying per year is only slightly increasing. These increases, according to the FAA, are only a
fraction of a percentage, thus creating a very slow current growth rate. However, the industry is
expected to see a dramatic increase over the next twenty years with projections nearly doubling,
which in turn will decrease the threat in future years (Price, 2012). In addition to the current
growth rate, it must be determined whether incumbents are currently meeting the demand for air
travel. According to the Bureau of Transportation Statistics, there are roughly twenty percent of
total seats available during each flight (U.S. Air Carrier Traffic Statistics Through November
2013, 2013). With this data, it can be assumed that there is an excess supply of flights; therefore,
the current providers must be meeting the demand. The two factors to potential threats for
retaliation indicate that there is a moderate to high risk for retaliation due to the current slow
market growth and the demand for flights being met by current providers.
The fifth barrier to be examined is learning curves, which are likely to exist when three criteria
are simultaneously present: the process within the industry is labor intensive, the task at hand is
repetitive, and lastly, the task being completed is complex (Warner, 2010). Although it is not as
labor intensive as the aircraft manufacturing process, the airline industry requires extensive
personnel in order to operate on a daily basis. Personnel include flight attendants, licensed pilots,
aircraft mechanics, airline ground operators, and so forth. Up until the early 2000s, labor costs
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accounted for the single largest factor in air carriers total costs (Warner, 2011). These high costs
represent how the industry is labor intensive. Within the air carrier industry, there is a lack of
repetition and diversity in tasks. While the process for transporting passengers from destinationto-destination is repetitive, each flight varies in numerous ways. Air carriers provide a service to
consumers, meaning each transaction is unique. While the process of flying is complex, it is
controlled mostly by computer generated schedules. The Air Traffic Control (ATC) system
manages flight patterns and routes. Its main purpose is to regulate aircraft, keeping planes a safe
distance apart at all times. All three criteria are not present simultaneously; therefore, the
likelihood of learning curves existing decreases. According to this analysis, learning curves
should be considered a low barrier to entry within this market.
The final potential barrier to analyze is that of governmental regulation. The air carrier industry
is one which receives regulation from several institutions. Particular government policies control
what firms may or may not enter the market. The Department of Transportation (DOT) handles
economic and financial factors of entering the market. It strives to insure firms are properly
educated on the complexity of operation within the market and that each is prepared to raise the
required amount of capital in order to do so. A firm and its managers must not have any record of
safety violations or fraudulent charges, in addition to proving it is owned and operated by U.S.
citizens (U.S. Air Carriers, 2012). The process for applying and completing an application to the
DOT takes a minimum of four months and costs $850 (Warner, 2011). This is just one example
of the costs incurred during government applications, in addition to the time it may take to enter
the market.
The Federal Aviation Administration (FAA), a sector of the DOT, poses barriers of entry with its
policies pertaining to the safety certification of civil flight. The FAAs responsibilities include
implementing safety certifications, enforcing the application of safety practices in order to
decrease the risk of operational hazards, and creating rules within the airline industry (Warner,
2011). A firm must apply to the FAA, in conjunction with its application to the DOT. The FAA
application is complex and consists of several parts. First, a firm must file a pre-application
statement of intent. This contains a summarization of management, the equipment that will be
used within the firm, and an explanation for the proposed venture. In order to prepare for the
next portion in the application process, an entrant needs to formulate safety processes, record
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operational aspects of the firm, develop manuals that will be used, etc. (Warner, 2011). If the
entrant receives approval from the pre-application, it is required to submit the prepared
information, in addition to a list of timeframes for every aspect of their business that will
undergo inspection by the FAA, projected operation conditions, and management personnel data
(Warner, 2011). Next, the decision to accept or decline the application follows. If and when an
entrants application is accepted, it continues on through performance and design assessments.
Overall, the process of applying to the Federal Aviation Administration is intricate, time
consuming, and costly. While there is no set time frame for the duration of this process, it can
take years for a firm to receive approval to enter the market. On average, it costs approximately
$15,000 for firms to apply to the FAA (Warner, 2011). From this, it can be concluded that
government policy poses a relatively high barrier when attempting to enter the air carrier
industry, due to restrictions during the extensive application processes and costs incurred when
doing so.
Upon concluding research of barriers to entry, it can be argued that there is an overall medium
barrier to entry for the air carrier industry. In the analysis there are three of the barriers to entry
(differentiation, switching costs, and learning curves) that provide little to no threat for potential
market entrants. However, channels of distribution, threats of retaliation, and government
regulations all posed high barriers to entry. It can be rationalized that with three of the potential
barriers possessing low barrier to entry and three possessing high barriers that there is an overall
medium barrier to entry in the market.
Supplier, Substitute, Rival, and Buyer Powers
An in depth analysis of Porters first force (barriers to entry) preceded this section. Furthermore,
an analysis of the remaining four forces will be discussed with respect to the air carrier industry.
These forces will be scrutinized to determine whether they are able to extract profits from the
industry.
Suppliers are considered powerful if they can increase the prices of the goods or services sold to
the focal industry. There are four tests that will be used to determine supplier power. If suppliers
are more concentrated than the focal industry then they are more powerful. Additionally,
suppliers are more powerful if there are no substitutes for what they provided. If suppliers can
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pose as a credible threat to integrate forward into the industry, then they are more powerful.
Lastly, if a supplier serves a wide variety of industries, so the focal industry is not their only
source of profit, then they are more powerful. The two main suppliers that will be assessed with
these tests are airports and plane manufacturers.
Airports are suppliers because they offer landing strips, ticket counters, and gates to air carriers.
There are 500 commercial service airports in the U.S., but most cities are only served by one
airport (Warner, 2011). Considering this fact, airports are more concentrated than air carriers
when considering a specific geographic area. This makes airports a powerful supplier since they
are the only option, or one of the few options, that an air carrier has if it wants to offer flights
into or out of a certain city. Airports are very powerful when it comes to substitutes because there
are no substitutes for them. Airports are the only places that have the means to support air
carriers. As for forward integration, airports do not pose a large threat. It would not be cost
effective for airports to forward integrate because of the high cost associated with creating an
airline firm. The airports would have to purchase a fleet of planes, secure gate space at other
airports and hire a new taskforce of employees. Lastly, air carriers are extremely significant to
airports because carriers are the only customers they serve. This means that airports in regards to
forward integration have low power as suppliers.
Plane manufacturers supply the aircraft that are used by air carriers to conduct their business.
Airbus and Boeing are the two main commercial aircraft suppliers with 84% of the market share
being controlled between them (Warner, 2011). A concentration test can be used to compare the
market shares of suppliers and buyers to determine which has more power. Airbus has 45% of
the commercial market and Boeing has 39%, which means that the C2 for suppliers is .840. As
for the market share of air carriers, Delta has 16.2%, United has 15.7%, Southwest 15.5%, and
American 12.8%. This means that the C4 for buyers is .602. The concentration test shows that
the suppliers (airplane manufacturers) are more concentrated than the buyers (air carrier
industry) so they are therefore more powerful.
There are no substitutes for airplanes that would satisfy the needs of the air carrier industry. This
also makes manufacturers very powerful. Manufactures could pose a threat with forward
integration because they would be able to produce a fleet of aircraft and barriers to enter the
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airline industry are relatively low. However, this would be an unlikely move for manufacturers
since commercial passenger firms account for 80% of their plane sales globally (Warner, 2011).
This shows that manufacturers are very dependent on the commercial airline industry because
most of their planes are produced for the industry. Because the industry is very significant to
manufacturers, suppliers have low power in this area.
The power that substitutes hold in the industry needs to be considered. To focus on substitutes, it
is critical to refer to the industry definition, which was defined as a set of firms striving to solve
travelers (business people and those flying for leisure) economic problems. Consumers needs
include timely transportation from one location to another, safe traveling conditions, competitive
pricing, and a variety of destinations. A substitute, by definition, is an alternative that strives to
create a solution which solves needs in a different way than the focal industry (Warner, 2010).
Some substitutes for the aircraft would be traveling by personal vehicle, taxi, bus, train, subway,
bicycle, or even by foot. Obviously, walking would not be sufficient for long distances,
exemplifying how substitutes differ in accurately meeting multidimensional needs. No substitute
is perfect at meeting customer needs in the exact same way the focal industry does.
Two factors need to be accessed in order to define substitute power in this industry. First, do the
customers face switching costs when choosing substitutes, and second, are the substitutes
accompanied by cost and quality tradeoffs? For this industry, switching costs can be evaluated as
the negative costs customers incur when switching forms of transportation. For example,
someone may choose to fly to Florida for vacation one year for spring break, then decide to drive
his or her own vehicle instead the next. The consumer may do so freely, with no repercussions.
No sunk costs are incurred, indicating that switching costs are not present in this industry, and
substitutes have high power.
As distance increases, so does the likelihood of traveling by plane. In trips over 1,000 miles, air
travel is the most popular form of transportation (Warner 2011). When assessing substitutes of
this industry, it is obvious that flying, especially long distances, is the fastest mode of
transportation. Reasons a consumer chooses to switch to a substitute may include quality issues
such as: bad experiences or fear of flying, poor customer service, lost baggage, late arrivals,
security/check-in hassles, the negative environmental impact, etc. (Peterson, 2010). Automobiles
17

are the next most frequently used option, due to the copious amount of interconnected roadways
across the United States. Travelers control the route in which they take, how fast they drive, how
often they stop for meals, rest, etc. Although driving provides flexibility, it can include extra
costs such as fuel, hotels, wear and tear on the vehicle, and most importantly, time. From this
example, it can be concluded that substitutes provide attractive quality characteristics that can be
cost-efficient, depending on distance. Between low switching costs and price/quality tradeoffs,
substitutes pose a threat to the airline industry (in trips shorter than 1,000 miles), causing a flow
of consumer money toward them and away from focal industry.
The third force that is examined in Porters forces is that of rivalry. Rivalry can be described as
the effect competition has on firms already existing within an industry (Warner, 2010). Five
various tests can be run to assess the strength of rivalry between firms. All test results will be
analyzed as strong (-1), moderate (0), or weak (+1) forces.
The first test deals with undifferentiated products or services. Within the air carrier industry,
consumers search for flights based on convenient scheduling and low price (Warner, 2011). This
suggests the air carriers compete by cutting prices, indicating a strong (-1) force of
undifferentiated services.
Second, rivalry is likely to exist when industry growth is slow. If industry growth is slow, firms
are likely to compete for each others market share. By looking at data from 2005-2013 and
comparing industry growth to national GDP, it can be concluded that the airline industry
fluctuates, producing very little growth, while the national GDP slowly increases (BTS, 2014). In
the eight-year span, the number of passengers to board airplanes has experienced negative
CAGR (Compound Annual Growth Rate) of -0.33%, while GDP has increased slowly by
approximately 3% (BTS, 2014). From this data, it can be analyzed that slow growth presents a
strong (-1) threat, increasing the likelihood of rivalry.
The third test is the presence of high fixed costs. Examples of fixed costs for air carriers are
airplanes, security fees, and airport gate fees. One Boeing aircraft, for example, can range from
$56.9 million to $485.2 million dollars (Warner, 2011). Obviously, an entire fleet of aircrafts
would be costly and capital intensive. Additionally, the air carrier industry is infamously known
as an industry with high fixed and variable costs. According to Investopedia, it one of the top
18

four reasons airlines struggle or fail (4 Reasons Why 2010). After the 9/11 tragedy, security
costs have increased greatly, causing yet another cost to incumbents. These many examples
indicate fixed costs within the industry are a strong (-1) force, increasing rivalry.
The fourth test deals with evaluating if the industry firms are more or less the same size. This can
be determined by developing a Herfindahl Index score. The HI was formulated in comparison
with the motorcycle industry in the U.S. which is dominated primarily by Harley Davidson,
while the air carrier industry has a much more equal distribution in market share. Approximately
60% of the market is controlled by the following firms: American (12.8%), United (15.7%),
Delta (21%), and Southwest (15.5%) (Peterson, 2013). Together, these firms had an index score
of .1380. Harley Davidson (65%), Honda (12.9%), Yamaha (1.4%), and Polaris (1.1%) scored an
index score of .4395 (Market, 2010). By comparing the two industries, it can be concluded that
rivalry among the airlines is relatively strong compared to the motorcycle industry. The HI
implies firms are relatively close in size, creating a strong (-1) source for rivalry.
Lastly, the fifth test analyzes how high strategic stakes are amongst incumbents. The top four
industry competitors (American, United, Delta, and Southwest) were assessed to see what
percentage of revenues come from the focal industry. It is standard across the industry for firms
to be involved in other businesses, such as cargo, private jet services, and vacation package
services, yet invest the majority of stakes within the focal industry. American Airlines, for
example, only generates 12.9% of its total revenue from other businesses (American Airlines,
2012). The remaining 87.1% of revenue indicates that this firm, like its competitors, invests high
stakes within the industry, creating a strong (-1) likelihood of rivalry. After summing the test
scores, an overall rivalry score of -5 proves that rivalry is a very strong force in the air carrier
industry and firms will mostly likely be competing based on price.
In summary, it was determined that switching costs are low and price/quality tradeoffs exist,
making substitutes a powerful force in the air carrier industry. In addition, after summing the
scores of the five rivalry tests, it can be concluded that rivalry is a strong force among industry
incumbents.
The final force of Porters that will be discussed is that of buyer power. The buyers in regards to
the airline industry are the final consumers such as leisure travelers and business travelers. There
19

are four questions that must be asked in regard to buyer power in order to determine the power
the buyer possesses (Warner, 2010). The first question that must be answered is, Are buyers are
more concentrated than the focal industry? In order to understand if the buyers are more
concentrated the C4 method can be used .Using the Bureau of Transportation Statistics website it
can be seen that Delta (16.2%), United (15.7%), Southwest (15.5%), and American (12.8%)
account for sixty percent of the market share (Airline Activity, 2013). Therefore the C4 for this
industry would be .602. This number indicates an extremely high concentration of the market
compared to the power of buyers within the industry. One buyer would have a C4 of practically
0. It can be concluded, in regards to the first test, that buyers are less concentrated than the focal
industry and therefore have low power.
The next test that must be examined is whether the focal industrys products are undifferentiated.
The products are differentiated if the buyer is willing to pay more for that particular product due
to brand loyalty. According to an article published by Forbes, many individuals belong to as
many as three frequent flyer programs (Olmsted, 2013). Furthermore, many passengers do not
belong to any FFPs, showing that they most likely base their decisions solely on price.
Therefore, it can be determined that buyers are not brand loyal and are looking for the most
beneficial option when purchasing a ticket. It can be concluded that the product is
undifferentiated and buyers have low power in this second test.
The third test for buyer power concerns the threat of backward integration. For this test, it must
be decided whether the buyer has the skills, knowledge and resources to become a supplier in the
industry. Previously, the barriers to entry for this industry were defined as moderate. These
barriers indicate that buyers would have difficulty backward integrating. In addition, it would be
incredibly difficult for buyers to obtain the knowledge required for backward integration. The
likelihood of buyers being able to build aircraft is unlikely, as manufacturing is complex. The
process requires specific skills, resources, and extensive knowledge. Between moderate barriers
to entry, in addition to lack of knowledge, buyers pose little threat to backward integration and
have low power in regards to this test.
The final test that is utilized deals with the portion of costs that is attributed to the industry from
a buyers income, i.e. Does the industry make up a significant portion of the buyers cost
20

component? In order to analyze this question, the average buyers yearly ticket expense in
regards to their yearly income must be examined. According to a report by CNN, the average
yearly income per household is $51,017 (15% of Americans Living in Poverty, 2013). The
average yearly expense per household on airline tickets is $178 (Airline Data and Analysis,
2013). This information shows that the total expense per year on airline tickets is small, leaving
the buyer low power.
The four tests used to evaluate the level of buyer power all show that the buyer has a low level of
power in regards to the airline industry. Therefore, the buyer has little power over the focal
industry to influence how the industry operates.

21

Competitive Advantage/Performance
A competitive advantage can be defined as using a combination of resources that leads to
profitability greater than the industry average (Warner, 2010).

CA can be measured by

comparing annual reports from competing firms within the industry. The following financial
profit margins can be used and analyzed to determine if a competitive advantage exists: Gross
Profit Margin (GPM), Operating Profit Margin (OPM), and Net Profit Margin (NPM). The
formulas for each are as follows:
GPM=

RevenueCost of Goods Sold

Sales

NPM=

Net Income
Total Revenue

OPM=

Operating Income
Total Revenue

For the air carrier industry, only OPM and NPM will be used, due to firms being service-based.
For each individual firm, the OPM and NPM are calculated. Then the industry averages for
operating income, total revenue, and net income are calculated. Using the industry averages, the
OPM and NPM are calculated again. Finally, the industry level OPM/NPM and the firm level
OPM/NPM are compared. Firms have a competitive advantage if the firm level margin exceeds
the industry level.
On the appendix table (Figure 1), ten firms were analyzed for competitive advantage, based on
market share within the industry. One very obvious outlier was American Airlines. Consistently
for the past five years, American has operated with a negative net income and OPM and NPM
below the industry average. This data shows that this firm did not possess a competitive
advantage. On the opposite end of the spectrum, successful firms containing a significant and
consistent competitive advantage included Alaska and Delta Airlines. For example, the industrywide OPM for 2013 was 6.55%. Delta was operating at 9.00%, while Alaska had a 16.25%
OPM. Steadily over the past five years, both firms showed similar trends. These numbers
indicate that both of these firms upheld a significant competitive advantage within the industry.
There are also firms in which contain a competitive advantage, like Southwest, which are not as
significant. From 2009-2013, Southwest produced an OPM slightly above the industry average.
22

Despite the numbers being close to industry average, by definition the firm still sustained a
competitive advantage because it operated with above average performance. These examples
show that some competitive advantages are stronger and more significant than others.
After completing the analysis of the ten firms, it can be concluded various degrees of competitive
advantages exist within the air carrier industry. If a firm has a competitive advantage with both
OPM and NPM, then it is earning enough revenue to pay for costs and still have a decent
income. A firm can have a low market share but still have a competitive advantage compared to
industry firms. Competitive advantage helps to determine whether a firm is operating
successfully against the other firms in the industry. Delta, Alaska, Southwest, and Jetblue airlines
all maintained sustainable competitive advantages, yet varied in the extent of performance. Delta
and Alaska clearly outperformed other industry participants, meaning these firms maintained the
most significant competitive advantages. American Airlines showed very poor performance
when compared with others industry participants over a five year span, indicating a lack of
competitive advantage within this firm.

23

Analysis of Key Firms

To gain a more comprehensive understanding of the airline industry, some of the main firms will
be examined in terms of their background, performance, and key resources. The firms that will
be included are Alaska Airlines, American Airlines, Delta Air Lines, Jet Blue Airlines, and
Southwest Airlines.
Alaska Airlines
Background: Alaska Air Group was founded by Linious McGee in 1932, when he started flying
a three-seated plane between Anchorage and Bristol Bay in Alaska. Two years later, the company
merged with Star Air Lines, creating Alaskas biggest airline at the time. In the 60s, the company
merged with Alaska Coastal-Ellis and Cordova Airlines. After the industry deregulation in 1979,
Alaska Airlines took advantage by expanding throughout the West Coast and merging with
Horizon Air and Jet America. Today, the company consists of two air carriers, Alaska Airlines
and Horizon Air, and is currently the seventh largest airline in the country. Headquartered in
Seattle, the company boasts more than 833 daily flights, offers over 100 destinations, and has
hubs in Anchorage, Los Angeles, and Portland, Oregon. Alaska employs 13,177 people of whom
10,201 are employed at Alaska and 2,976 at Horizon. Labor unions represent 83% of Alaska and
49% of Horizons workforce.
Performance: Traditionally, Alaska Airlines has performed well above industry average. Alaska
has profit margins that exceeded the industry average, with nearly double the OPM and NPM for
years 2009-2013 compared to the industry average. The results for the period 2009-13 are shown
in Figure 1 of the appendix.
Resource Analysis: Two resources for Alaska will be assessed: the culture of the company and
the corporate environmental sustainability resource.
Culture
Known as the Alaskan Spirit, Alaska Airlines culture is valuable because of its enthusiastic
workforce and on-time performance. According to Alaskas SEC file, the airline ranked the
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highest in customer satisfaction among traditional carriers by J.D. Power and Associates for the
sixth year in a row (Alaska Air Group, 2014). The company was also ranked as the best major
airline in the U.S. by the Wall Street Journal and led the major U.S. airlines with 86% on-time
performance (Sarena, 2014). Alaska achieves a positive image due to its industry leading ontime performance which enables more flights per day. Alaska outranked Southwest for customer
service for six straight years due to its high set standards and employee training. Overall, the
characteristics of Alaskas culture are rare. In order for other airlines to imitate Alaskas culture,
an airline would need to restructure its strategy, implement employee training programs, and
outsource labor. Each of these characteristics would be extremely costly to implement and are
not very feasible for incumbents. New entrants may pursue this strategy only if the entrants can
surpass the barriers to entry. A companys culture is not easily substitutable. Organizational
culture is a mindset and a cognitive process and is something that may take years to cultivate.
Overall, Alaska Airlines unique culture provides a competitive advantage.
Corporate Environmental Sustainability
Alaska Air Groups Corporate Environmental Sustainability Plan reduces carbon emissions, fuel
usage, and embraces recycling (ALASKA, 2014). Since 2004, Alaska has reduced its carbon
footprint by 30%. Fuel efficiency is driven by the airlines fleet of Boeing 737s and Bombardier
Q400, among the most efficient of aircraft. In addition, by investing in satellite navigation, better
airport operations vehicles and installing winglets, the firm has saved 10 million gallons of fuel
since 2011. Since fuel is roughly 40% of operational cost, this has enabled the airline to achieve
the status of most fuel efficient airline (PR, 2014). The airline hopes to use biofuels in 2020 in
more than one airport. Another fuel saving method the firm is adopting is the use of new airport
approaches that shorten the distance used to approach the runway, saving more than 2 million
gallons of fuel per year (PR, 2014).
Alaska Airlines fleet and weight reduction saved approximately 10 million gallons of fuel since
2011: the value of cost savings is significant (PR, 2014). Since the firm is rate the most efficient
carrier, Alaskas environmental strategy is rare, for now. However, there is no reason other firm
cannot begin to implement the same practices as they are not costly. Indeed, Southwest is already
installing winglets on most of its fleet. As a result, this resource will soon become imitated and it
25

will not be a source of competitive advantage. This resource is providing a temporary

competitive advantage.
American Airlines
Background: American Airlines traces its roots back to the early days of aviation in the 1920s.
The firm, headquartered in Fort Worth, Texas, was a mail carrier service until 1936 when it
became a commercial service under the firms president, Cyrus Rowlett Smith. By the 1980s,
American served 260 airports in more than 50 countries and territories. The fleet numbers nearly
900 aircraft and on average, services more than 3,300 daily flights. (History of AMR Corporation
and American Airlines, 2011).
On November 29th, 2011, American Airlines' parent company, AMR Corporation, filed for
bankruptcy. Americans planned reorganization to exit bankruptcy included the acquisition of US
Airways, proposed in February, 2013. By December, 2013 the Department of Justice dropped
objections to the merger after the firms agreed to give up key takeoff and landing positions at
airports in Washington, D.C., and New York. The two firms will continue to function as two
separate airlines for sometime until operations run smoothly (Isidore & Ellis, 2011; Arnold,
2013; PR Newswire, 2013) .
Performance: American has struggled in profitability for years. The results for the period 200913 are shown in Figure 1. American has not only lagged in the industry average on both
profitability indicators for all five years, but has also posted net profitability losses in all years.
Resource Analysis
At this stage, American does not have resources that lead to superior or even average
performance. Factors will be examined as to what factors are actually extracting value from the
firm.
American Airlines has been paying roughly $800 million more in labor costs annually than all
the other firms, due to labor contracts (Isidore & Ellis, 2011). American's labor cost accounts for
approximately 28% of revenues, making it the highest of any major airline operating in the U.S.
today. Delta, United, and US Airways labor costs are only 18%, 20%, and 17% of revenues
26

(Sanati, 2012). In the airline industry there are not many ways to even out this cost other than to
raise ticket prices. Raising ticket prices would just cause customers to move to another airline.
Another serious problem that American Airlines has faced in recent years has been fuel costs. In
recent years their fleet has become outdated compared to other firms in the industry. The older
planes being used by American require more fuel, thus forcing American to spend more money
on fuel when fuel prices have been rising. At one point, from January of 2008 to April of 2008,
American Airlines was losing nearly $3.3 million a day due to the combination of rising fuel
prices, labor costs, and 300 aircraft being decertified by the FAA (Gimbel, 2008.). In order to
turn this around, American has placed the largest aircraft order in history, purchasing 460 narrow
body planes with the order split between Boeing and Airbus (Johnson, 2011). On average, one
new airplane is being delivered to them every week (Our planes, n.d.). These planes are more
fuel efficient and also feature new interior designs with larger seats that allow more leg room.
A third problem for American is a long history of poor relations with the labor unions. One of
the most recent examples involved contract disputes with pilots following the bankruptcy
declaration that caused more than 12,000 flights to be delayed and more than 1,000 to be
canceled in September of 2012 alone (Johansen, 2012). The merger of the four major unions
from each of American and U.S. Air and solving problems of seniority, especially among pilots,
may continue to add to the problem.
Delta Air Lines
Background: Delta Air Lines operated its first passenger flight from Dallas, TX, to Jackson,
MS, in 1929. In later years, the company changed its headquarters to Atlanta, GA. In 1950, Delta
expanded internationally and implemented the hub and spoke airline system, which is still used
today. Northeast Airlines and Delta merged in 1972, leading to a major presence in New York
and Boston. Another merger took place in 1987 when Delta merged with Western Airlines to
become the fifth largest carrier worldwide and the fourth largest carrier domestically (History,
2011). Delta experienced several years of fiscal hardship, fluctuating between profitability and
loss, within the 1980s to the 1990s. The 2000s brought new alliances and strategies. The mid2000s brought economic hardship for Delta, causing them to file Chapter 11 bankruptcy. When
Richard H. Anderson became the eighth CEO of Delta in 2007, restructuring took place, helping
27

the company out of bankruptcy. Delta acquired Northwest Airlines and developed a marketing
and codeshare agreement with Alaska Airlines in 2008. Delta has performed above industry
averages in profit margins since 2010 and continues to thrive from the merger that took place
with Northwest.
Performance: Delta Air Lines, Inc. has performed above the industry average from 2010-2013.
In 2009, the industry-wide operating profit margin average and net profit margin was very low.
This indicates that the industry, including Delta, experienced economic hardship. In the years
that followed, Delta recovered and operated consistently above the OPM/NPM industry
averages. Figures 1 illustrates Deltas consistent above average performance, indicating the firm
may possess a long-term competitive advantage.
Resource Analysis
Two of Delta Airlines resources will be analyzed using Barneys VRIN model: its extensive hub
and spoke system and use of refurbished planes. The model assesses the resources in terms of
whether each is valuable, rare, imitable, and non-substitutable. If a resource meets these
requirements, it may lead to a competitive advantage for the firm.
Deltas Extensive Hub System:

V: Yes R: Yes

I: No

N: N/A

Delta operates through a hub and spoke system with a strong collection of hubs in dense
metropolitan areas including Atlanta, Detroit, New York (LaGuardia), and Minneapolis. Records
from Vaughn Cordle of Ionosphere Capital show that Deltas collection of hubs is the most
profitable in the airline industry (Tully, 2014). This information proves that the operating system
is valuable and critical for Deltas success. The basic hub and spoke system is very common
among incumbents, yet not to the extent in which Delta has established. Through its hubs, Delta
succeeds at appealing to business travelers. The company has the highest satisfaction rating with
corporate travelers, in comparison with its competitors (Levine-Weinber, 2013). Deltas hub in
Atlanta is the worlds busiest airport, and Delta often controls 80% of incoming and outgoing
flights. Delta also handles 79% of the flights in Detroit and 77% of the flights in Minneapolis
(Tully, 2014). These statistics show that Deltas hub and spoke system is extensive and capital
intensive, making it difficult to imitate. Deltas hub and spoke system is valuable, non-imitable,
28

and rare due to its size, complexity, and ability to attract corporate travelers. It can be concluded
that this system gives Delta a competitive advantage within the industry.
Refurbishing Used Planes: V: Yes R: Yes I: Yes

N: No

An extremely large expense for airlines is maintaining a fleet of aircraft. Delta is combating this
issue with a unique approach. Instead of purchasing new aircraft, Delta focuses on buying used
planes and refurbishing them. This is valuable because it greatly decreases the cost of
maintaining a fleet. Delta invests $10 to $13 million into refurbishing a used MD90, rather than
paying $40 million for a new 737 (Tully, 2014). This practice is relatively rare because most
airlines prefer to make the investment in new aircraft. Even though Deltas practice is not
common, it can be easily imitated by other firms. Lastly, refurbishing used aircraft can be
substituted with buying or even leasing aircraft. From this, it can be determined that refurbishing
airplanes is not the source of a sustainable competitive advantage for Delta Air Lines.
The presented information indicates that the use of refurbished airplanes does not contribute to
Deltas competitive advantage, but does help contribute to cost efficiency. Although hub and
spoke systems are common within the industry, Delta has developed a complex and valuable one,
focused on metropolitan areas to attract corporate travelers. By passing all of the VRIN model
tests, Deltas hub and spoke system proves to offer a potential competitive advantage for the
firm.
Jet Blue
Background: JetBlue operates out of JFK airport in New York City and began service with
routes across New York State and to Florida. It has now extended to a dominantly East Coast
structure with transcontinental flights to Los Angeles, San Francisco, and the Pacific northwest
as well as destinations in the Caribbean and South America. JetBlue was founded in 1999 by a
group of executives with substantial experience in the air carrier industry, many with Southwest.
The firm was the first to specifically imitate Southwest in a general way and helped create what
has come to be known as the Low Cost Carrier segment of the industry.

29

The management conceived and implemented employee selection based on the company core
values of safety, caring, integrity, fun and passion. Airbus A320s were ordered to provide
customers with a more comfortable ride on their flights. With the companys combined mix of
low cost services and comfortable flying experience, the firm began winning numerous awards
such as Best New Airline and Best Overall Airline. On the other hand, the firm has
experienced some notable missteps, including the Valentines Day crisis in 2007 that was a
leading reason for the passage of the Passenger Bill of Rights.
Performance: In recent years, JetBlue has consistently outperformed competitors in profit
margins. During the period of 2009-2012, the firms operating profit margin and net profit
margin were above industry average.

JetBlue maintained these above average margins

throughout all four years. See Figure 1.

Resource Analysis:
Two resources will be assessed for JetBlue: the fleet of A320s and the culture of the company.
JetBlues Fleet
Approximately 70% of JetBlues active fleet is the A320 (Planespotters, 2014). Jet Blue has one
of the most modernized fleets and is very technologically advanced in the industry. JetBlue is
also about to add another plane in the second quarter of 2014, which will then lead four different
types of aircraft being utilized. The newest plane will be an A321 and will be thought of as a
refreshed version of the JetBlue flying experience.
The fleet of A320s is valuable because repair costs and costs for parts are reduced due to less
need for storage. Having the fleet is rare amongst the top competitors (Delta, United, and
American) who all have mixed fleets and run a hub and spoke system. Southwest and Spirit
Airlines are the only companies that operate with a 100% standardized fleet. The fleet is imitable
by newcomers trying to join the industry but does not seem to be financially beneficial for
current firms in the industry to replace their current fleets. There are substitutes for the fleet. The
A320s are modernized but technology is always advancing and a plane with better performance
will be produced sooner than later. We conclude that JetBlues fleet has provided them with a

30

competitive advantage for many years but the ongoing threat of technology is slowly diminishing
that advantage.
Culture
JetBlues culture is a resource that provides the firm with a competitive advantage. Its core
values of safety, caring, integrity, fun and passion are what drives the firm today. With fun as
one of the core values, it truly shows that the firm strives to keep its customers as well as its
employees happy. The firms instillation of the Lift program is another example of its culture.
This program allows employees to recognize each other for exceptional work which leads to
stronger camaraderie between peers.
The firms culture is valuable because it leads to a lower average turnover rate than the industry
average. The company has numerous awards including multiple Best Low Cost Airline awards,
#1 Airline Brand awards, Best Airline awards, Most Customer Friendly awards, along with many
more. This shows that customers and employees have taken notice of the culture that JetBlue
offers. This is reflected in both the awards, as well as the low turnover rate. The culture is rare
because it puts the firm ahead of the competition in customer loyalty. In its first year of business,
JetBlue recorded only .6 complaints per 100,000 passengers compared to an industry average of
2.99. Its on-time record of 80% beat the industry average of 74% during its first year of
operation as well. Being the industry leader in loyalty shows a rare resource that customers
recognize and appreciate with continued business. The culture is not imitable because it is one of
the few airlines without a unionized labor force. When compared to the rest of the industry
which is 80% unionized, it is difficult to imitate a culture that does not have a unionized labor
force. The culture is not substitutable because another firm simply cannot purchase another
culture. A firms culture is extremely difficult to instill as it takes time and effort, as well as the
belief of the employees in the culture for it to work. For these reasons the culture is not imitable.
With this VRIN analysis is can be determined that JetBlues culture is a strong competitive
advantage.

31

Southwest Air
Background: Southwest Airlines origins as a small, intrastate carrier in Texas and subsequent
slow, sequential market expansion, led to the development of the key resources and competences
that made it successful for many years. For example, the company preferred smaller airports
even if larger were available in a city because gate costs and landing fees were one third to one
quarter those of major airports (Heskitt & Hallowell, 1993). Southwest never had a hub because
of the way it grew incrementally, adding routes slowly and developing a point to point system
instead. The desire to serve the Dallas-Houston market with hourly flights compelled Southwest
to develop a fast turnaround time of ten minutes as that permitted the route to be served with just
two aircraft versus three. Even after Southwest expanded to become an interstate carrier, these
practices and competences persisted and became key resources.
Performance: Southwest has posted profitable performance every year since 1973. While still
well above industry average, profit margins had begun to slide relative to other competitors in
2007 through the recession. The results for the period 2009-13 are shown in Figure 1.
Southwests position has eroded to some extent as several years show performance at roughly
industry average.
Resource Analysis
Two resources for Southwest will be examined: the fleet of Boeing 737s and the culture of the
company.
Fleet
Southwests fleet is composed exclusively of Boeing 737s. This now includes the AirTran fleet,
which originally included other aircraft models. As of the end of 2013, the company operated
680 aircraft. Roughly 85% of the planes are fitted with winglets for fuel efficiency (Southwest,
2014a).
This fleet is valuable because maintenance costs in both labor and parts are reduced and the firm
saves flight crew costs in that all pilots are qualified to fly all aircraft. This reduces headcount
and increases flexibility in staffing flights. The fleet is rare among major competitors. The
32

network carriers (United, Delta, American) all have mixed fleets to service a hub and spoke
structure. Jetblue had historically used an all A320 fleet but has recently moved to include
Embraer craft. Only Spirit Airlines currently operates a homogenous fleet. The fleet is inimitable
by incumbents as moving to a single platform would not be economical in serving a hub and
spoke system. The H&S is economical to the extent that it can use both large and small aircraft
efficiently. A single platform would be underutilized in small markets and be too small to handle
hub based traffic. New entrants can imitate the homogenous fleet. There are partial substitutes
for the fleet if outsourced maintenance for a mixed fleet results in cost savings. From 1997 to
2007, outsourced maintenance increased from 37% to 64% of expenditures for all carriers and is
projected to climb (McFadden & Worrells, 2012). We conclude that while the fleet has provided
Southwest with a performance edge for many years, substitution is eroding that advantage. In
general, this resource now provides competitive parity.
Culture
Southwests culture is valuable because it helps (or has helped) reduce costs on several fronts.
First, low turnover means reduced hiring and training costs. The cost to replace an employee can
run as much as 20% of annual salary (Lucas, 2012). The culture has been valuable historically as
the firm led the industry in labor cost/ASM productivity until 2004 where the position began to
erode until Southwest had the second highest rate (Inkpen, 2013). The culture is rare as noted
above: no other firm in the industry has been so honored as Southwest on cultural dimensions. It
is also inimitable by large, existing firms - at least in the near term. Cultural change is difficult
and complex, particularly if institutional history has been characterized by animosity and
mistrust. However, the culture can be imitated by entrants as Jetblue management demonstrated
(Gittell & OReilly, 2001). Part of the original value (productivity) has been substituted by
comparatively lower labor costs among other carriers and this is expected to continue. We
conclude that Southwest still holds something of a competitive advantage from culture relative to
the network carriers but not at all versus other low cost carriers as imitation and substitution have
taken hold.

33

Air Carrier Industry Evolution

The purpose of this paper is to analyze the air carrier industry by predicting how it may change
in the future with respect to industry incumbents, market leaders, and potential risks. McGahans
dimensions of evolution, threats to core activities and core assets, will also be addressed.
Entrance of Imitators/Re-organization of Incumbents
Over recent years, the airline industry has seen a major restructuring of many key competitors in
the market. Initially, many entrants were present, yet as the market underwent deregulation in
1979, competition increased, leading to a drop in industry incumbents. Within the last twelve
years, ten of the top airline firms have merged into four mega carriers: American Airlines, Delta,
United, and Southwest. These incumbents control roughly two-thirds of the overall market share
(66.4%) (IBIS, 2014). Now that these firms have condensed and an oligopoly has begun to form,
it is unlikely that there will be another major reorganization among these top firms. If the top
industry incumbents chose to merge any further, the government would likely intervene due to
the creation of a monopoly within the market. Another possible effect to the structure of the
market is the entrance of new firms to the industry. Throughout this analysis, it has been
determined that it would be difficult for a new firm to enter the market because of the moderate
barriers to entry. Currently the market is highly saturated and competitive. In addition, the
dominant carriers control a large portion of the market share, creating high risk for new entrants
and minimal share in which to earn control over.
Maturing of the Leading Firms
With the increasing cost of flying, many people are finding alternatives, whether it is driving,
using a conference call, or simply not traveling at all. Considering this trend, leading firms
within the airline industry cannot continue to operate as they are currently. High prices are
pushing customers away, so airlines need to find ways to lower prices without hurting the firms
bottom line. Decreasing operating costs is an ongoing dilemma for airlines, meaning the most
profitable firms must successfully manage finances in order to survive within the industry.

34

Mistakes by Incumbents
Mistakes by incumbents are more likely to occur if there is a change in upper management or if
the industry becomes volatile. New executives can have missteps when trying to change how a
firm operates. The industry can also cause firms to make critical mistakes if it becomes volatile
due to technological changes. Currently, technology within the airline industry is rather stable.
However, this could change in the future with new air traffic technology advancements currently
underway. As previously discussed, NextGen has the potential to revolutionize the industry as a
whole, but it could cause difficulties when firms begin adjusting to the new system. This new
software will most likely be very costly for incumbents to implement. Airports will operate
solely using NextGen technology once it is available for use, eliminating the old radar navigation
system. Planes will be traveling in more fuel efficient patterns, saving time and fuel costs,
meaning even if radar airports still exist, firms will not be able to compete with those who are
utilizing the efficiency of the new system. Overall, the transition to new technology could cause
instability within the industry, which could lead to mistakes being made by incumbents if they do
not make the switch.
Threats to Core Activities (PEST)
To assess the threats to the industrys core activities, it is necessary to return to the previous
PEST analysis where the political, economic and technological environments were evaluated.
First, the political environment within the industry poses concern through the government's
opposition of new mergers. In 2013, the Department of Justice filed a claim attempting to block
the merger of American Airlines and US Airways Group (Justice, 2013). In addition, the court
also assessed other mergers which had taken place. Eventually, the challenges were dropped due
to firms agreeing to certain divestitures (Wilson, 2013). Moving forward, the government will be
attempting to stop the creation of a monopoly that would raise ticket prices, directly affecting all
consumers. In addition to the restriction of mergers, air carriers may experience government
regulations dealing with fuel efficiency and the use of more sustainable resources. This would

35

lead to new investments in greener technology by the firms, in order to meet regulations, which
would directly increase the overall operating expense.
Within the economic environment of the air carrier industry, the issue of increasing oil prices is
present. As oil prices continue to raise so does the cost of jet fuel. Furthermore, this directly
correlates to a rise in cost of airline tickets for passengers, as the cost of fuel expenses account
for nearly forty percent of an airlines expense per flight (Seaney, 2014). If the price of flights
climbs too high consumers will be forced to switch to less-costly alternative forms of
transportation. This would lead to a decrease demand for flights, directly effecting incumbent
revenue and ability to produce profits. It is extremely difficult to predict what will happen with
oil prices in the future, as the cost of fuel is constantly fluctuating. Even if oil prices stabilize, it
is still going to be a large portion of operating expenses for firms.
Lastly, the use of technology within the air carrier industry poses a threat to core activities
through the increase in videoconferencing technology. As discussed previously in the PEST
analysis, new videoconferencing software is being implemented by businesses, in order to
decrease the need for business travel. Recently, Google introduced a system that retails for under
$1,000 (Thomson, 2014). This technology exemplifies how cost efficient implementing video
conferencing has recently become, posing a threat to airlines. If businesses choose to invest in
such software, airlines will experience a decrease demand for business flights, which currently
creates a large portion of their target market.
Threats to Core Assets
The most important assets that a firm possesses are both its fleet and gate space at airports. A
firms fleet can become an issue as it ages. Older planes are less fuel efficient so they cost more
to operate. Furthermore, they can have more mechanical problems so increased maintenance
could be required. Planes out of commission for maintenance cost a firm money, due to the labor
involved to fix the aircraft. In addition, out of commission planes take away potential revenue
that could be earned in passenger routes. Firms must also purchase or lease new planes to keep
fleets up-to-date and running efficiently. However, this is very costly and can strain a firms
financials.

36

The other asset that is crucial to a firm operating successfully is its gate space at airports. Airlines
must have the appropriate amount of gates at the airports in which they operate in order to
accommodate customers correctly. Gate space can make or break how well an airline performs
financially because flights need to be offered in areas of customer demand. Since competition is
very intense between airlines, acquiring gate space can be very difficult. Industry incumbents
will continue to compete for gate space, while working to maintain an efficient and cost effective
fleet.
Additionally, in the attempt to lower costs, many firms may try to transition to the structure of a
low cost carrier. If this transition occurs, LCC firms would continue to grow and threaten legacy
carriers. Carriers such as American, Delta, and United would receive increased pressure to offer
lower prices in order to compete with the LCC structure. This could greatly damage the legacy
carriers profits and make operating as they are accustomed to extremely difficult.
Conclusion
Within the next few years, the air carrier industry will no longer undergo mergers between the
top firms in the market, due to the government striving to prevent a monopoly from forming.
However, mergers may be seen on a smaller regional carrier level. Risks may arise when new
technology is implemented, which could cause the industry to become volatile. Overall, the
industry should continue to be controlled by a few mega carriers, which will continue to compete
for increased market share.

37

Recommendation
The airline industry is in the mature stage of its life cycle and is controlled by a few mega
carriers. Additionally, some regional carriers are dominating in their respected areas. Due to the
state of the airline industry, it is recommended that new firms should not be created because it
would be hard to enter the industry successfully. The barriers to entry relating to governmental
regulations, channels of distribution, and threats of retaliation can be considered high, which
makes entering the airline industry difficult.
Additionally, extracting profits from the industry can be challenging. Operating expenses are
very large, which decreases the profitability of an airline. This problem can affect both new
entrants and incumbents in the airline industry. One expense that can greatly affect profits of
firms is fuel for planes. It is suggested that a firm updates its fleet in order to take advantage of
the increased fuel efficiency in new planes. However, due to the fact that planes are extremely
expensive, firms should develop a plan as to how to purchase planes without causing a strain on
financials. This plan could involve buying planes in small quantities so a large investment is not
made all at once. The cost of the new planes should be spread out over multiple years.
Air carriers need to be very cautious of how they operate in the future and be wary of other
competitors. Due to the fact that mergers between mega carriers are unlikely to happen in the
near future because the government would intervene, competition should increase. Firms will
need to compete more fiercely with one another to attract customers. Success for airlines will
depend on how effectively each can gain market share from competitors, while minimizing costs
to increase profits.
There are three options when considering entering the domestic airline industry: do not enter the
industry, enter the industry as a regional carrier, or enter the industry as a national carrier. The
first option of not entering the industry is most likely the best choice as the difficulty to entrance
and succeeding within the airline industry was previously discussed. Entering the industry would
be a very high risk investment. The second best option would be entering the industry as a
regional carrier. Currently, regional carriers are performing well within the U.S., but the market
is quickly becoming saturated. This option offers potential for success but the risk may not be
38

feasible. A firm would have to develop a competitive advantage and control costs in order to
generate profits. The last option of entering the industry as a national carrier is not advised. This
level of the industry is controlled by four mega carriers, in which control over 60% of market
share. This would make gaining a significant portion of market share incredibly difficult.
The air carrier industry is very complex and the dynamics have changed drastically over the
years. Due to this, many firms have failed, but few have managed to be successful. Of the firms
still in existence, some will survive and prosper, while others will eventually die out. Even
though the airline industry can be difficult in which to operate, it should stay an extremely
important part of long distance travel until new technologies render plane travel obsolete.

39

Appendix
Figure 1

40

41

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